The Standard Mortgage Clause
Many commercial property policies contain a clause that protects a mortgage holder's right to obtain compensation for a loss even if the insurer has denied a claim filed by the policyholder. This provision is referred to as the standard mortgage clause.
A standard mortgage clause was created almost one hundred years ago to address the needs of lenders. Many properties were being purchased with mortgages, and lenders wanted to ensure they would be compensated for losses under the borrowers' property policies even if the borrowers violated policy conditions. Lenders helped draft wording that could be attached to borrowers' policies.
Nowadays, many property policies include a mortgage clause similar to the one found in the ISO commercial property policy. Entitled Mortgageholders, this clause is located in the policy conditions. It outlines the obligations the insurer must fulfill if mortgaged property is damaged or destroyed. This clause is considered a standard mortgage clause because it affords protections to lenders.
Required By Lenders
When a business owner purchases a commercial building with a mortgage, the mortgage holder will likely require the buyer to obtain a property policy that includes a standard mortgage clause. Suppose you own a wholesale building supply business and have purchased a new warehouse with a mortgage from Lucky Lending. The warehouse will serve as collateral for your loan so Lucky Lending has an insurable interest in it.
To protect Lucky's interest, your loan agreement requires you to insure the warehouse under a commercial property policy that includes a standard mortgage clause. This means it must include a clause similar to the one found in the ISO property policy.
Who Is Covered?
The ISO mortgage clause applies to the mortgage holder named in the commercial property declarations. The policy should list the mortgage holder's name and mailing address, and include a description of the mortgaged property. The term mortgage holder includes a trustee. In some states, lenders secure their loans via deeds of trust rather than mortgages.
If multiple lenders are listed in the policy, they are covered in order of precedence. For example, suppose that a policyholder has purchased a building with two mortgages (a first and a second). If the building burns down, the lender listed on the first mortgage will be paid. After the first lender has been compensated, the lender on the second mortgage will receive payment.
The mortgage clause covers each lender listed in the policy for loss or damage to the building or structure in which the lender has an interest. Lenders receive payment "as their interests may appear." This means that the amount paid to each lender depends on the extent of damage to the insured building and the unpaid balance (principal and interest) of the loan.
For example, suppose a fire destroys your warehouse. When the fire breaks out you owe Lucky Lending $750,000 in principal and accrued interest. Lucky's interest in the property is $750,000 so your insurer sends it a claim payment for that amount.
Note that any claim payment your insurer makes is subject to the limit on your policy. The limit is the most your insurer will pay for loss or damage in any one occurrence. If your warehouse is insured for $750,000, your insurer will pay no more than that amount to all covered parties combined (your company and all lenders).
Protections for the Lender
The ISO mortgage clause contains several important safeguards for lenders.
The lender's right to recover for a loss under the borrower's property policy is not affected by any foreclosure action the lender has initiated against the property owner prior to the loss. For example, suppose that you have missed several mortgage payments, so Lucky Lending issues a notice of default against your firm. One month after the notice has been issued, your warehouse is destroyed by a fire. The default notice will not affect Lucky's right to receive payment for the loss under your policy.
Acts of Policyholder
The mortgagee (lender) has a right to recover for a loss under the policy even if the policyholder has violated a condition of the insurance contract. For example, suppose that your warehouse is destroyed by a fire. You file a claim with your property insurer for damage to the building and its contents. Your insurer dispatches an adjuster to inspect the damage but you refuse to let him on your premises. Your insurer ultimately denies your claim because you have failed to allow it to inspect the damaged property (a policy condition).
The policyholder's breach of the insurance contract will not affect the lender's rights to recover under the policy if the lender fulfills all of the following conditions.
- Pays any outstanding premium the policyholder has failed to pay
- Submits a proof of loss (if the policyholder has not done so) within 60 days of receiving a notice that a proof of loss is due
- Notifies the insurer if the lender becomes aware of any change in the building's ownership, occupancy or risk
Cancellation and Non-renewal
The mortgage clause requires the insurer to notify the mortgage holder in writing if the insurer cancels the policy or refuses to renew it. If the insured has failed to pay the premium, the insurer must notify the lender 10 days in advance before canceling the policy. If the insurer cancels the policy for any reason other than non-payment of the premium, it must provide 30 days' advance notice to the lender. Should the insurer decide not to renew the policy, it must provide the lender ten days' notice.
The cancellation conditions in the ISO form may be modified by state law. For instance, some states require insurers to provide lenders at least 45 days prior notice if the policy is cancelled for any reason other than non-payment of premium.
Transfer of Rights
The Mortgageholders clause contains a separate subrogation provision that applies when the insurer has made a loss payment to the lender but has denied payment to the insured. In this event, the lender's rights of subrogation are transferred to the insurer to the extent of the amount of the payment.
For example, suppose that your warehouse burns down and your insurer pays Lucky Lending $750,000, the lender's interest in the property. Your claim is denied because of your refusal to comply with the policy's inspection condition. The fire was caused by a defect in an electric dryer stored in your warehouse. If Lucky Lending was not compensated for the damage under your policy, it could sue the dryer manufacturer for property damage.
Because your property insurer has indemnified Lucky Lending for the loss, the lender's right to sue the manufacturer is transferred to your insurer. The insurer now has the right to sue the manufacturer to recover the $750,000 it has paid to Lucky Lending.
The insurer may pay the lender the principal amount on the mortgage plus any accrued interest. In this case, the insured's mortgage and note will be transferred to the insurer. If any debt remains, the policyholder must pay that amount to the insurer.